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Get these FREE Forex Scalping Cheatsheets. Try this 1500 pips a day Strignao’s Forex Signals and learn how to trade like pros from Tom Strignano- An EX CHIEF BANK TRADER. Lean this 10 minute a day Swing Trading Strategy. Interest rate changes are always keenly watched by the market analysts. Interest rate change by any Central Bank can have implications for many currency pairs. Especially in case of US, when FED decides to increase or decrease the interest rate, it has global implications and affects many currency pairs including all those having US Dollar (USD) on either side as a base currency or counter currency. FOMC ( Federal Open Market Committee) of the FED is responsible for deciding the interest rate changes in US. FOMC meetings are the second most market moving releases after the NFP (Nonfarm Payrolls). So always watch out for FOMC announcements.

Currency markets are also highly susceptible to interest rate changes. An interest rate differential in forex trading means the difference between the interest rate on the base currency (first currency in the pair) minus the counter currency (the second currency in the pair). Everyday at 5:00 PM EST, funds are either paid by trader to their brokers or received by traders from their brokers depending on whether the interest differential is negative or positive on the currency pairs they are trading. So knowing these interest rate differentials is highly vital for a currency trader.

Majority of investors are primarily yield seekers. Large banks, hedge funds, corporations, pension funds and institutional investors are always shifting their funds from low yielding assets to high yielding assets.

Now, let’s take an example to make things more clear. Take the example of Switzerland and United States. Suppose, Swiss 10 year government bonds are paying a yield of 5.5%. On the other hand, the US 10 year government bond also known as a US Treasury Note is only paying 2.0% interest. The yield spread between the two government bonds will be 3.5% or 350 basis points. This yield spread is in favor of Switzerland. Swiss government wants more foreign investors to come to Switzerland and deposit their money in Swiss Banks. Now, Swiss government decides to further increase the interest rate by 0.5% or 50 basis points. The new bond yield spread will be now 4.0% or 400 basis points. More foreign investors will start flocking towards Switzerland. This will place an upward pressure on Swiss Franc (CHF) and in the near future CHF will appreciate relative to USD.

So how do you calculate the interest rate differentials for currency pairs? The best method is to use yields on the 10 year government bonds. THe data is easily available on Bloomberg. For example, in case of GBPUSD pair subtract the yield on 10 year US Treasury Note from the British 10 year gilt. But, in case of EURUSD use German 10 year bond instead of gilt. Keeping track of the trend in interest rate differentials overtime can give you a leading indication of appreciation or depreciation of a currency relative to the other in the currency pair.

Make a graph of this interest rate differential overtime! If this graph is steadily moving up, it means that the currency pair is going to appreciate and if it is steadily going down, it means that the currency pair will depreciate. Understanding this correlation between the currency pair prices and the interest rate differential can be highly profitable for your currency trading career!

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